Africa: Global Economic Crisis, 3

Editor's Note

"The welfare of developed and developing countries is mutually
interdependent in an increasingly integrated world economy.
...Without a truly inclusive response, recognizing the importance
of all countries in the reform process, global economic stability
cannot be restored, and economic growth, as well as poverty
reduction worldwide, will be threatened. This inclusive global
response will require the participation of the entire international
community; it must encompass more than the G-7 or G-8 or G-20, but
the representatives of the entire planet, from the G-192." - United
Nations Commission of Experts on Reforms of the International
Monetary and Financial System

[Note: for greater readability, the detailed sequential paragraph numbering in the original has been omitted
in this html version.]

Note by the President of the General Assembly

The outbreak of the financial crisis in 2008 originated in the
advanced developed countries, but has spread quickly to become a
world economic crisis that affects all countries, including the
emerging economies and less developed countries.

To review the workings of the global financial systems and to
explore ways and means to secure a more sustainable and just global
economic order, I have convened a Commission of Experts, chaired by
Professor Joseph Stiglitz, 2001 Nobel laureate Prize winner in
Economics, and comprised of a outstanding economists, policy
makers, and practitioners drawn from Japan, Western Europe, Africa,
Latin America, South and East Asia. These experts were chosen based
on their comprehensive understanding of the complex and
interrelated issues raised by the workings of the financial system.
The Commissioners are also individuals recognized for their strong
grasp of the strengths and weaknesses of existing multilateral
institutions as well as their sensitivity to the particular
challenges facing countries from different regions of the world and
at different levels of economic and social development.

I now have the pleasure to transmit the preliminary
recommendations of the Commission for your consideration. These
recommendations and the analysis that underlies them will figure
prominently in the interactive thematic dialogue on "The World
Financial and Economic Crisis and its Impact on Development", which
I will convene from 25 to 27 March 2009 at United Nations
Headquarters in New York. It is my hope that Members of the General
Assembly will find these recommendations, and the dialogue next
week, useful as they prepare for the United Nations Conference on
World Economic and Financial Crisis and Its Impact on Development,
which will be convened in little more than two months time in
accordance with General Assembly resolution 63/239 of 24 December
2008.

The Commission of Experts on Reforms of the International Monetary
and Financial System

Recommendations

19 March 2009

I. Preamble

The rapid spread of financial crisis from a small number of
developed countries to engulf the global economy provides tangible
evidence that the international trade and financial system needs to
be profoundly reformed to meet the needs and changed conditions of
the 21st century. Past economic crises have had a disproportionate
adverse impact on the poor, who are least able to bear these costs
and that can have consequences long after the crisis is over.

While it is important to deal with the structural changes to
adapt the international system to prevent future crisis, this
cannot be achieved without significant measures to promote recovery
from the current crisis whose impact may be even worse than in the
past. The International Labour Organization estimates that the rise
in unemployment in 2009 compared to 2007 of 30 million could reach
more than 50 million if conditions continue to deteriorate. Some
200 million people, mostly in developing economies, could be pushed
into poverty if rapid action is not taken to counter the impact of
the crisis on developing countries. Even in some advanced
industrial countries, millions of households are faced with the
threat of losing their homes and access to health care, while
economic insecurity and anxiety is increasing among the elderly as
they lose their life-time savings in the collapse of asset prices.

The welfare of developed and developing countries is mutually
interdependent in an increasingly integrated world economy. Short
term measures to stabilize the current situation must ensure the
protection of the world's poor, while long term measures to make
another recurrence less likely must ensure sustainable financing to
strengthen the policy response of developing countries. Without a
truly inclusive response, recognizing the importance of all
countries in the reform process, global economic stability cannot
be restored, and economic growth, as well as poverty reduction
worldwide will be threatened.

This inclusive global response will require the participation of
the entire international community; it must encompass more than the
G-7 or G-8 or G-20, but the representatives of the entire planet,
from the G-192. It was to respond to this need that the President
of the General Assembly created the present Commission of Experts
to address the measures needed to meet the crisis and recommend
longer term reforms. Recognising work being undertaken by the G-8
and the G-20, and other bodies, the Commission sees its own work as
complementary, seeking to focus on impacts of the crisis and
responses to the crisis on poverty and development. 5. Reform of
the International system must have as its goal the better
functioning of the world economic system for the global good. This
entails simultaneously pursuing long term objectives, such as
sustainable and equitable growth, the creation of employment in
accordance with the "decent work" concept, the responsible use of
natural resources, and reduction of greenhouse gas emissions, and
more immediate concerns, including addressing the challenges posed
by the food and financial crises. As the world focuses on the
exigencies of the moment the long standing commitments to the
achievement of the Millennium Development Goals and protecting the
world against the threat of climate change must remain the
overarching priorities; indeed, appropriately designed global
reform should provide an opportunity to accelerate progress toward
meeting these goals.

II. Responding to the Global Financial Crisis

Sustainable responses to the crisis require identifying the
factors underlying the crisis and its rapid spread around the
world. Loose monetary policy, inadequate regulation and lax
supervision interacted to create financial instability. The results
were manifest in the large global imbalances whose disorderly
unwinding in the absence of prompt countercyclical measures may
aggravate the crisis.

Part of the reason for inadequate regulation was an inadequate
appreciation of the limits of markets what economists call "market
failures." While such failures arise in many markets, they are
particularly important in financial markets and can have
disproportionately large consequences as they spill over into
"real" economic activity.

The conduct of monetary policy can be traced in part to an
attempt to offset an insufficiency of global aggregate demand,
aggravated by increasing income inequality within most countries.
Monetary conditions were also influenced by the accumulation of
foreign exchange reserves by some emerging market countries seeking
protection from global instability and onerous conditions
traditionally attached to assistance from the multilateral
financial institutions.

The current crisis reflects problems that go beyond the conduct
of monetary policy and regulation of the financial sector. It also
involves deeper inadequacies in areas such as corporate governance
and competition policies. Many of these failings, in turn, have
been supported by a flawed understanding of the functioning of
markets, which also contributed to the recent drive towards
financial deregulation. These views have been the basis for the
design of policies advocated by some of the international economic
institutions, and for much of the architecture of globalization.

More generally, the current crisis has exposed deficiencies in
the policies of some national authorities and international
institutions based on previously fashionable economic doctrines,
which held that unfettered markets are, on their own, quickly
self-correcting and efficient. Globalization too was constructed on
these flawed hypotheses; and while it has brought benefits to many,
it has also enabled defects in one economic system to spread
quickly around the world, bringing recessions and impoverization
even to developing countries that have developed good regulatory
frameworks, created effective monetary institutions, and succeeded
in implementing sound fiscal policies.

The Principles and Recommendations outlined in this Report seek
to address the underlying problems. They focus both on feasible
interim steps that can and should be taken immediately, and the
deeper medium and longer term reforms that are necessary if we are
to make another such crises less likely, and if we are to
strengthen the international community's capacity to respond to a
crisis, should one occur.

In analyzing appropriate national and global responses to the
crisis, the Commission noted the following principles:

Failure to act quickly to address the global economic downturn
inevitably would increase its depth and duration and the eventual
cost of creating a more balanced robust recovery.

In a globally integrated world, the actions of any one country
have effects on others. Too often these externalities are not taken
into account in national policy decisions. Developed countries in
particular need to be aware of the adverse consequences of these
externalities, and developing countries need frameworks to help
protect themselves from regulatory and macro-economic failures in
systemically significant countries.

Developing countries should have expanded scope to implement
policies and create institutions that will allow them to implement
appropriate counter-cyclical policies.

Advanced industrial countries should observe their pledges not
to undertake protectionist actions, and even more importantly
insure that stimulus packages and recovery programs do not further
distort the economic playing field and further increase global
imbalances.

Measures to restore domestic financial markets in developed
countries through subsidies to financial institutions have been
accompanied by a sharp reduction in flows of capital to developing
countries. It is important to ensure that these measures do not
create a new form of financial protectionism. Financial subsidies
can be just as detrimental to the efficiency of a free and fair
trading system as tariffs. Indeed, they may be far more
inequitable, because rich countries have more resources to support
subsidies.

Greater transparency on the part of all parties in responding
to the crisis is necessary. More generally, democratic principles,
including inclusive participation in decision making, should be
strengthened and respected.

The crisis is, in part, a result of excesses in deregulation of
financial markets and in international trade. Restoring the global
economy to health will require restoring a balance between the role
of the market and the role of the state.

In responding to this crisis, it is imperative that actions to
improve conditions in the short term do not result in structural
changes which increase instability or reduce growth in future.

It is essential that governments undertake reforms that address
some of the underlying factors that contributed to the current
economic crisis if the world is to emerge from the crisis into
sustainable, balanced growth. It is not enough simply to return to
the status quo ex ante.

Appropriately designed short run measures may be complementary
to long term goals, especially those related to climate change and
the environment.

III. Immediate Measures

The current crisis must be met with rapid and effective
measures, but it must also lay the basis for the long-run reforms
that will be necessary if we are to have a more stable and more
prosperous global economy and avoid future global crises.

Ten immediate measures are essential for global recovery.

1. All developed countries should take strong, coordinated, and
effective actions to stimulate their economies.

Stimulus should be timely, have large "multipliers," help
address the strains posed by the economic downturn on the poor,
help address long run problems and prevent instability. While the
decision on stimulus is national, it should be judged on its global
impacts; if each country looks only at the national benefits versus
costs, e.g. an increased national debt, the size of the global
stimulus will be too small, spending will be distorted, and the
global impact will be eviscerated.

National stimulus packages should thus include spending
measures to be undertaken in developing countries to offset the
impact of the decline in world trade and financial market
disintermediation. Industrialised countries should thus dedicate
1.0 per cent of their stimulus packages, in addition to traditional
official development assistance commitments.

2. Developing countries need additional funding

More permanent and stable sources of funding for developing
countries (See Section IV.10 below) that could be activated quickly
and are not subject to inappropriate conditionality are necessary.
Indeed, additional funding would be required just to offset the
imbalances and inequities created by the massive stimulus and
bail-out measures introduced in advanced industrialised countries.
Such funding could be provided by an issuance of Special Drawing
Rights approved by the IMF Board in September 1997 through the
proposed Fourth Amendment of the Articles of Agreement to double
cumulative SDR allocations to SDR 42.8 billion and through the
issuance of additional SDRs through standard procedures.

In addition regional efforts to augment liquidity should be
supported. For instance, extension of liquidity support under the
Chiang Mai initiative without an IMF program requirement should be
given immediate consideration. Regional cooperation arrangements
can be particularly effective because of a greater recognition of
crossborder externalities and greater sensitivities to the
distinctive conditions in neighbouring countries.

These additional sources of funding should be in addition to
traditional official development assistance. Failure to maintain
the levels of official assistance will have long-term effects.
There will be an increase in poverty and malnutrition and the
education of many young people will be interrupted, with life-long
effects. The sense of global social solidarity will be impaired,
making agreement on key global issues, such as responding to the
challenges of climate change, more difficult. Failure to provide
such assistance can be counterproductive even in a more narrow
sense: it can impair the global recovery.

Developed countries must make a renewed effort to meet the
commitments made in the Millennium Declaration, the Monterrey
Consensus, the 2005 Global Summit, and the Doha Declaration by
2015.

3. Mobilizing Additional Development Funds by the Creation of a New
Credit Facility

The creation of a new credit facility is thus a matter of
urgency. If such a facility could be created in a timely way, it
could be a major vehicle for the disbursement of the requisite
additional funding.

Given the need for rapid response, the new credit facility
might be more quickly established under the umbrella of existing
institutions, such as the World Bank, where efforts are underway to
remedy existing inadequacies in governance and lending practices,
or in Regional Development Banks where developing countries have
more equitable representation.

Or alternative institutional arrangements that create
competition amongst institutions providing financial assistance
might be envisaged. Such competition might not only increase the
efficiency of disbursement, but also reduce the application of
procyclical conditionality linked to financial support.

Whatever form is chosen, the new facility should have
governance more reflective of democratic principles, with strong
representation of developing countries and those countries
contributing to the facility. These new governance arrangements
might provide lessons for the reform of existing institutions.

Administration of the Facility could be done by staff seconded
from existing multilateral financial institutions or central banks.
The new facility could draw upon financial contributions from all
countries. It could leverage any equity funds contributed by
borrowing, including on the market or from those with large
reserves or Sovereign Wealth Funds. Its ability to borrow could be
enhanced through guarantees provided by governments, especially
those of the advanced industrial countries. These alternative
arrangements should be seen as a complement to expanded financial
support from existing institutions,

4. Developing Countries need more policy space

There are asymmetries in global economic policies
countercyclical policies are pursued by developed countries, while
most developing countries are encouraged or induced to pursue
pro-cyclical policies. While this is partly due to the lack of
resources to pursue countercyclical policies, it is also due to
misguided policy recommendations from international financial
institutions. Conditionality attached to official lending and
support for international financial institutions has often required
developing countries to adopt the kinds of monetary and regulatory
policies which contributed to the current crisis. In addition,
these conditionalities contribute to global asymmetries,
disadvantage developing countries relative to the developed, and
undermine incentives for developing countries to seek support
funding, contributing to global economic weakness. While the IMF
initiatives to reduce conditionalities are to be commended, they
might be insufficient, while in many cases countries are still
required to introduce pro-cyclical policies.

5. The lack of coherence between policies governing trade and
finance must be rectified.

Policy space is circumscribed not only by a lack of resources,
but also by international agreements and by the conditionalities
that often accompany assistance. Many bilateral and multilateral
trade agreements contain commitments that circumscribe the ability
of countries to respond to the current crisis with appropriate
regulatory, structural, and macro-economic reforms and rescue
packages, and may have exposed them unnecessarily to the contagion
from the failures elsewhere in the global economic system.
Developing countries especially need policy frameworks that can
help protect them from regulatory and macro-economic failures in
systemically significant countries. Developing countries have had
imposed on them not only deregulation policies akin to those that
are now recognized as having played a role in the onset of the
crisis, but also have faced restrictions on their ability to manage
their capital account and financial systems (e.g. as a result of
financial and capital market liberalization policies); these
policies are now exacting a heavy toll on many developing
countries.

6. Crisis response must avoid protectionism

Overt protectionism includes tariffs and domestic restrictions
on procurement contained in some stimulus packages. Because of
complex provisions and coverage of international trade agreements,
seemingly "symmetric" provisions (e.g. exceptions of the
application of provisions to countries covered by particular WTO or
other international agreements) can have markedly asymmetric
effects. Subsidies, implicit and explicit, can, as has been noted,
be just as distorting to open and fair trade. There may, in some
cases, be pressure for banks receiving large amounts of government
assistance to focus on lending domestically. While the temptation
that gives rise to such measures is understandable, efforts need to
be made to finance additional support to developing countries to
mitigate the impact of the crisis as well as of both open and
hidden subsidies (i.e. state assistance through lending programs
and guarantees) in order to avoid further distortions.

7. Opening advanced country markets to least developed countries'
exports

While a successful completion of the Doha trade round would be
welcome, its impact on the crisis and its development dimension are
still unclear (see IV.9, below). There are, however, a number of
measures that have already been agreed in multilateral trade
negotiations which could be implemented rapidly to support
developing countries impacted by the crisis. These include
implementation of dutyfree, quota-free market access for products
originated from LDCs. In addition, the agreement reached at the WTO
s Hong Kong Ministerial session in 2005 provided for the
elimination of all forms of developed country export subsidies, at
the latest by 2013, should be implemented immediately. There is no
reason to await a general agreement before implementing these
measures. In addition, domestic support for cotton subsidies should
be abolished immediately, as they distort prices to the detriment
for African countries. More generally, in all trade negotiations,
the long recognized principle of special and differential treatment
of developing countries should be preserved.

8. Learning from Successful Policies to undertake Regulatory
Reforms.

The financial crisis is widely viewed to be the result of the
failure of regulatory policies in the advanced industrial
countries. While full regulatory reforms (discussed more
extensively in section IV.6 below) will take time, it is imperative
that work on regulatory reform begin now. The collapse in
confidence in the financial system is widely recognized as central
in the economic crisis; restoration of confidence will be central
in the recovery. But it will be hard to restore confidence without
changing the incentives and constraints facing the financial
sector. It is imperative that the regulatory reforms be real and
substantive, and go beyond the financial sector to address
underlying problems in corporate governance and competition policy,
and in tax structures, giving preferential treatment to capital
gains, that may provide incentives for excessive leverage. While
greater transparency is important, much more is needed than
improving the clarity of financial instruments. Even if there had
been full disclosure of derivative positions, their complexity was
so great as to make an evaluation of the balance sheet position of
the financial institutions extraordinarily difficult. Still, there
is need for much greater transparency, including forbidding off
balance sheet transactions and full expensing of employee stock
options.

Well regulated economies have to be protected from
competition from economies with inadequate or inappropriate
regulatory systems. The problems of regulatory arbitrage and tax
evasion are closely linked. Tax havens and financial centers in
both developed and developing countries that fail to meet basic
standards of transparency, information exchange and regulation
should be given strong incentives to reform their practices, e.g.
by restricting transactions between financial institutions in those
jurisdictions and those in more highly regulated countries.
Institutional arrangements for improving harmonisation and
transparency should be strengthened, including the United Nations
Committee of Experts on International Cooperation in Tax Matters as
proposed in Paragraph 16 of the Doha Declaration. Also other
international arrangements and conventions such as United Nations
Convention against Corruption should also be strengthened.

9. Coordinating the Domestic and Global Impact of Government
Financial Sector Support

Government bail-outs have substantial redistributive
consequences that must be analysed in assessing their impact on
recovery. In addition, because of the urgency of the situation they
often fail to observe principles of good governance and especially
of democratic transparency. This may lead to the introduction of
inappropriate incentives, as well as failure to recognise possible
adverse effects on other countries, especially on developing
countries that lack equivalent financial resources.

Developed countries should undertake their financial support
policies recognising that even symmetric policies can have
asymmetric effects because guarantees by developing country
governments are likely to be less meaningful than those by
developed countries.

Failure to recognise these wider domestic and global
consequences of financial support measures have often meant that
the costs to the government and to developing countries have been
higher than necessary. Funds have often been redistributed to those
with higher incomes, and have created distorted incentives. Support
measures for financial institutions that are implemented by Central
Banks risk imposing high costs on the public purse, without
adequate parliamentary oversight of appropriations. Greater
transparency on the part of all parties would facilitate a more
effective response to the crisis.

10. Improved coordination of global economic policies

There is a need for substantial improvement in the coordination
of global economic policy. Global economic integration has outpaced
the development of the appropriate political institutions and
arrangements for governance of the global economic system.
Remedying this lacuna is a matter of urgency, discussed at greater
length in section IV.3, but this will not happen overnight.

In the short term, there should be an appropriate mechanism
within the United Nations System for independent international
analysis on questions of global economic policy, including its
social and environmental dimensions. Following the successful
example of the Intergovernmental Panel on Climate Change (IPCC), a
similar panel could be created to offer consultancy to the General
Assembly and ECOSOC, but also to other international organizations
to enhance their capacity for sound decision-making in these areas.
At the same time, such a panel would contribute to foster a
constructive dialogue and offer a regular venue for fruitful
exchange between policy makers, the academic world and key
international organisations. The panel should comprise well
respected academics from all over the world, appropriately
representing all continents, as well as representatives of
international social movements. Being made up of outstanding
specialists, the panel should be able to follow, analyse and assess
long-term trends, key developments and major dynamics for global
change affecting all people around the globe, identify problems in
the global economic and financial architecture, and jointly provide
options for coherent international action and recommendations for
political decisionmaking processes.

IV. Agenda for Systemic Reforms

There is an equally important agenda of deeper systemic reforms
to the international system, that should begin now, if we recovery
is to be sustainable.

1. A New Global Reserve System

The global imbalances which played an important role in this
crisis can only be addressed if there is a better way of dealing
with international economic risks facing countries than the current
system of accumulating international reserves. Indeed, the
magnitude of this crisis and the inadequacy of international
responses may motivate even further accumulations. Inappropriate
responses by some international economic institutions in previous
economic crises have contributed to the problem, making reforms of
the kind described here all the more essential. To resolve this
problem a new Global Reserve System what may be viewed as a greatly
expanded SDR, with regular or cyclically adjusted emissions
calibrated to the size of reserve accumulations could contribute to
global stability, economic strength, and global equity. Currently,
poor countries are lending to the rich reserve countries at low
interest rates. The dangers of a single-country reserve system have
long been recognized, as the accumulation of debt undermines
confidence and stability. But a two (or three) country reserve
system, to which the world seems to be moving, may be equally
unstable. The new Global Reserve System is feasible,
non-inflationary, and could be easily implemented, including in
ways which mitigate the difficulties caused by asymmetric
adjustment between surplus and deficit countries.

2. Reforms of the Governance of the International Financial
Institutions

There is a growing international consensus in support of reform
of the governance, accountability, and transparency in the Bretton
Woods Institutions and other nonrepresentative institutions that
have come to play a role in the global financial system, such as
the Bank for International Settlements, its various Committees, and
the Financial Stability Forum. These deficiencies have impaired the
ability of these institutions to take adequate actions to prevent
and respond to the crisis, and have meant that some of the policies
and standards that they have adopted or recommended disadvantage
developing countries and emerging market economies. Major reforms
in the governance of these institutions, including those giving
greater voice to developing countries and greater transparency are
thus necessary.

The reform of the World Bank's governance structure should be
completed swiftly. For the second stage of the reform, focussing on
the realignment of shares, three criteria could be taken into
account: economic weight, contribution to the development mandate
of the World Bank (for example, measured in terms of contributions
to IDA and trust funds), and the volume of borrowing from the Bank.

For the IMF, serious consideration should be given to
restoration of the weight of basic votes and the introduction of
double or multiple majority voting.

Elections of the leaders of the World Bank and the
International Monetary Fund should take place under an open
democratic process.

3. A Global Economic Coordination Council.

A globally representative forum to address areas of concern in
the functioning of the global economic system in a comprehensive
way must be created. At a level equivalent with the General
Assembly and the Security Council, such a Global Economic Council
should meet annually at the Heads of State and Government level to
assess developments and provide leadership in economic, social and
ecologic issues. It would promote development, secure consistency
and coherence in the policy goals of the major international
organisations and support consensus building among governments on
efficient and effective solutions for issues of global economic,
governance. Such a Council could also promote accountability of all
international economic organizations, identify gaps that need to be
filled to ensure the efficient operation of the global economic and
financial system, and help set the agenda for global economic and
financial reforms. It would be supported intellectually by the work
of the International Panel discussed in III.10. Representation
would be based on the constituency system, and designed to ensure
that all continents and all major economies are represented. At the
same time, its size should be guided by the fact that the council
must remain small enough for effective discussion and decision
making All important global institutions, such as the World Bank,
IMF, WTO, ILO and members of the UN Secretariat dealing with
economic and social issues would provide supporting information and
participate in the Council. It could thus provide a democratically
representative alternative to the G-20.

4. Better and more balanced surveillance.

The surveillance of economic policies should be especially
focused on systemically significant countries, those whose bad
performance is most likely to have global consequences. Such
surveillance should focus not just on inflation, but on
unemployment, financial stability, systemic stability related to
the presence of built in stabilizers or destabilizers, and systems
of social protection.

5. Reforming Central Bank Policies to promote Development

Whereas price stability is desirable in support of growth and
financial stability, it is not sufficient. Central Banks should
therefore aim to ensure price stability in the context of
delivering long-term sustainable growth, while being sensitive to
the risks to financial stability, capital flows and exchange rates.
Central banks also need to give consideration to financial market
and asset price developments. This may entail Central Banks using
a wider range of instruments, including prudential instruments. A
distinction may need to be made between the roles of Central Banks
in maintaining financial stability under normal circumstances and
during crisis periods. Central Bank governance arrangements may
need to differ depending on their precise role. In particular, in
any actions which may impose serious risks on a country's fiscal
position, such as those now being implemented in many countries as
part of financial institution resolutions, should be subject to
coordination.

6. Financial Market Policies

Financial policies, including regulation, have as their
objective not only ensuring the safety and soundness of financial
institutions and stability of the financial system, but protection
of bank depositors, consumers and investors and ensuring financial
inclusion - such as access to all banking services including
credit, and the provision of financial products which help
individuals and families manage the risks they face and gain access
to credit at reasonable terms. It is also imperative to make sure
that the sector is competitive and innovative.

Financial institutions have been allowed to grow to be too big
to fail, imposing enormous risk on the global economy. And while
there has been innovation, too much of the innovation was aimed at
regulatory, tax, and accounting arbitrage, and too little at
meeting the real needs of ordinary citizens. Too little was done to
help developing countries and ordinary homeowners manage the risks
which they face, with consequences that have been repeatedly
apparent. Financial regulation must be designed so as to enhance
meaningful innovation that improves risk management and capital
allocation.

The current crisis has made it apparent that there are large
gaps and deficiencies in the regulatory structures in place in many
systemically significant countries. It is also apparent that while
effective regulatory system must be national there must be some
global regulatory framework to establish minimum national standards
and also govern the global operations of systemical relevant global
financial institutions. The Report of the Commission will identify
a number of key aspects of regulatory reform, emphasizing the need
for deep and pervasive reforms and highlighting the risks of merely
cosmetic changes in regulations. The following items are among the
key aspects of needed reform.

(a) Financial Product Safety

Sustainable recovery will depend on appropriate regulations
(across countries, products, and institutions). Regulations should
be based on what things are, not what they are called, i.e.
insurance products should be regulated the same way, whether called
insurance or not. Financial regulators should be mandated to
ascertain the safety and appropriate use of various financial
instruments and practices, including through the creation of a
Financial Products Safety Commission.

Core depository institutions should be restricted from
undertaking excessively risky activities and tightly regulated.
There also needs to be close oversight over all highly levered and
all systemically significant institutions. But there should be
oversight over all financial institutions. Institutions can quickly
change into systemically significant.

(b) Comprehensive Application of Financial Regulation

The fact that correlated behavior of a large number of
institutions, each of which is not systemically significant, can
give rise to systemic vulnerability makes oversight of all
institutions necessary. There needs to be tighter regulation of
incentives, especially in the core institutions; part of the
current problem is a result of distorted incentives which
encouraged short sighted and excessively risky behavior. It may be
easier to regulate incentives than every manifestation of perverse
incentives. There need to be restrictions on leverage, with
automatic countercyclical capital adequacy and/or provisioning
requirements.

Although the activities of private investment funds, equity
funds and hedge funds did not trigger the financial crisis, their
regulation is not globally uniform, creating the potential for
regulatory arbitrage and the potential for gaps in regulation.
Funds should be registered in the countries of their operations and
provide appropriate regulation to regulatory authorities. In
addition, banks must define limits for transactions with hedge
funds.

There should be no retreat from mark to market accounting for
institutions with shortterm funding in order to provide full
transparency for investors and regulators. Other institutions may
be encouraged to supplement mark-to-market accounting with
valuations that are more appropriate to the maturity of their
liabilities. In addition, steps should be taken to enforce
transparency norms and public accountability for all public
companies.

(c) Regulation of derivatives trading

The large scale use of unregulated, unsupervised OTC
derivatives has resulted in undue complexity, opacity, and
mis-pricing of these instruments, and facilitated capital avoidance
by financial institutions. These practices have weakened our
financial system significantly and made resolution of failing firms
extremely difficult.

Where appropriate steps should be take to develop regulated
exchanges for trading standardized contracts of systemically
significant derivative contracts, with the associated regulatory
restrictions including limits on non-commercial traders.
Regulations should insure that derivative instruments are held on
balance sheets, valued at independently audited real transaction
prices, with appropriate capital provisioning, and clarity of
purpose. The use of over the counter contracts by core institutions
should, in general, be discouraged, but whenever used, there should
be ample and adequate margin.

(d) Regulation of Credit Rating Agencies

Other needed reforms, including for Credit Rating Agencies and
systems of information provision are addressed in an Appendix.

The Financial Stability Forum was created in the aftermath of
the 1997-8 financial crisis in order to promote international
financial stability, improve the functioning of financial markets
and reduce the tendency for financial shocks to propagate from
country to country, and to enhance the institutional framework to
support global financial stability. It is now apparent that the
reforms that it has proposed, although important, have not been
sufficient to avoid major global financial instability. If it is to
become the main instrument for the formulation of reforms of the
global financial system it must take into consideration the
importance of financial stability for the development of the real
economy. In addition it must increase the representation of
developing countries to adequately reflect the views and conditions
in these countries and be made accountable to a democratically
representative institution such as the Global Economic Coordination
Council proposed above.

The development of financial institutions that are too big to
fail has played an important role in the development of the crisis
and has made the resolution of the crisis both difficult and
costly, both for taxpayers and for the global economy. It is
imperative not only that is adequate oversight of these large
institution but that efforts be made to limit their size and the
extent of their interactions, to limit the scope of systemic risk.
This will require more effective global cooperation in financial
and competition regulation. Movement towards this goal might be
enhanced by taking steps to lay the groundwork for a Global
Financial Regulatory Authority and a Global Competition Authority.
With so many firms operating across borders, it is difficult to
rely on national regulatory authorities. There may be large
externalities generated by the action (or inaction) of national
authorities. A potential, but partial, remedy to this difficulty is
the proposal for a College of Supervisors to oversee systemically
relevant global financial institutions. This could provide a basis
for a more comprehensive Global Authority.

(f) Host Country regulation of foreign subsidiaries

In the absence of adequate global coordination, financial
sector regulation will need to be based on the host country, not
the home country, and may entail requiring the establishment of
subsidiaries, rather than relying on branches.

(g) Regulatory institutions

While inadequate regulations are partly to blame for the
current crisis, in some cases good regulations were not effectively
applied and enforced. This highlights the need for reforms in
regulatory structures, including reforms that make the possibility
of regulatory capture less likely. The weaker is the system of
global regulation, the more segmented will financial markets have
to be to ensure global stability.

7. Support for Financial Innovations to Enhance Risk Mitigation

The absence of global systems of risk bearing and the absence
of and in some cases resistance to innovations that would
facilitate efficient risk bearing, such as GDP indexed bonds and
mortgage products which better manage the risks associated with
home ownership must be remedied. Governments and the international
financial institutions need to explore meaningful innovations that
would enhance risk management and distribution and how markets
might be encouraged to do a better job. In particular, while there
have been some expansion in capital markets in domestic currencies
in developing countries, developing countries still bear the brunt
of exchange and interest rate fluctuations. IFI lending in
(possibly baskets of) local currencies and the provision of
exchange and interest rate cover might be important steps in
improving international risk markets.

There is an urgent need for renewed commitment to develop an
equitable and generally acceptable Sovereign Debt Restructuring
Mechanism, as a well as an improved framework for handling cross
border bankruptcies. One way by which this might be done is through
the creation of an independent structure, such as an International
Bankruptcy Court. The United Nations Commission on International
Trade Law provides a model that could be extended to the
harmonization of national legislation on cross border disputes
dealing with trade in financial services.

A number of countries may face difficulties in meeting their
external debt commitments as the crisis worsens and debt
rescheduling becomes more and more difficult due to an increase in
creditors not represented in the Paris Club. The current crisis has
already seen a number of bankruptcies of companies that operate
across national borders, and their number is likely to increase.
The absence of a formal mechanism for dealing with the impact of
cross border bankruptcy and insolvency, especially when related to
financial institutions, transmits the adverse economic effects to
the global economy.

It is especially important to achieve a uniform approach to
financial and investment disputes on bankruptcy and insolvency,
given the fact that the regulations dealing with these matters
included in bilateral free trade agreements often transcend
existing multilateral treaties and national legislation.

9. Completion of a Truly Development-Oriented Trade Round

There is a need for a true development round, to create an
international trade regime which truly promotes growth in the
developing countries. It is essential, that in all trade
negotiations, the long recognized principle of special and
differential treatment of developing countries be preserved.

10. More Stable and Sustainable Development Finance

The need for more and more stable sources of finance for
development, including for the investments needed to address the
long run challenges of responding to climate change, and new
institutions for disbursement of funds, is discussed in Section
III.4 above.

In the absence of better systems of risk mitigation, it is
especially important for developing countries to be wary of
measures that expose them to greater risk and volatility, such as
capital market liberalization. Developing countries should use all
the tools at their disposal, price interventions, quantitative
restrictions, and prudential regulations, in order to help manage
international capital flows.

Market-driven international capital flows are of a magnitude
and volatility that they can offset any formal mechanism to provide
additional finance for development. Thus, an active management of
foreign capital inflows will be required to ensure that they are
supportive of government counter-cyclical policies. The Articles of
Agreement of the International Monetary Fund provided to members
the facility of controlling capital inflows and expressly excluded
the use of Fund resources to meet imbalances resulting from capital
account disequilibrium. The Fund should thus be encouraged to
return to its first principles and support countries that attempt
to manage external flows in support domestic counter cyclical
policy.

The international community needs to explore a variety of
mechanisms of innovative finance, including regular emissions of a
new global reserves (SDRs), revenues generated from the auction of
global natural resources (such as ocean fishing rights and
pollution emission permits), and international taxes (such as a
carbon tax, which would simultaneously help address problems of
global warming, or a financial services tax, which would
simultaneously help stabilize international financial markets.)

The receipts could be directed to support the developing
countries costs of reducing greenhouse gas emissions in the context
of their national policies to promote sustainable development. The
effective implementation of national systems of taxation form a
crucial part of domestic development finance. Measures must be
taken to preserve national autonomy in the selection of the sources
and methods of government financing while ensuring that national
differences do not create incentives to evade responsibility of
contributors to the support of government policies. An efficient
method of achieving this result would be the acceptance by all
countries of an amendment of Article 26 of the United Nations Model
Double Taxation Convention between Developed and Developing
Countries to make the exchange of information automatic.

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